Concentration Problems

There are plenty of perks associated with climbing the corporate ladder more money, a corner office with a view, a bigger expense account, to name a few. But one benefit, company stock, can also be a burden. When executives have the majority of their assets tied up in their company's stock or stock options, as many of the wealthiest do, they can be at the mercy of the stock market a vulnerable position

There are plenty of perks associated with climbing the corporate ladder — more money, a corner office with a view, a bigger expense account, to name a few. But one benefit, company stock, can also be a burden.

When executives have the majority of their assets tied up in their company's stock or stock options, as many of the wealthiest do, they can be at the mercy of the stock market — a vulnerable position indeed, given the heightened volatility of the past few years. If their company's stock dives, they may not have enough assets elsewhere to absorb the blow.

According to a study of senior executives that we've just conducted, this lack of diversification is a problem that's not being addressed by their financial advisors.

In a Nutshell

We surveyed 388 senior executives, vice presidents or higher, in publicly traded, Fortune 1000 companies. Four out of five of the respondents were male, they were all over 45 and each had been working for the same company for at least a decade. About one-half of the respondents had $500,000 to $1 million in investable assets, one-third had $1 million to $5 million and one-fifth had more than $5 million.

The study shows an interesting correlation between affluence and a lack of diversification: the wealthier the respondent, the higher the percentage of assets in company stock. The $5 million-plus group allocated almost two-thirds of their assets to company stock, the middle group about 50 percent of assets and the sub-$1 million group, about a third of assets.

It is hardly surprising then that when we asked them about their key financial concerns, diversification was very important. The higher the net worth of the respondent, the more pronounced the concern.

One might well ask, given this high level of concern, why wasn't something done about it? Perhaps the issue went unidentified by their financial advisors, or perhaps the best solution was put aside because of its complexity. Indeed, for many of these executives, the answer to their concentrated stock conundrum is probably a hedging strategy of some sort. But hedging, for all its cocktail-party cachet, remains one of the most complicated and least understood financial options.

Hedging can allow people who have concentrated stock positions to manage risk in a tax-effective manner. Hedging can also help them take advantage of the possible upside without selling their shares. That's an important option, because if the company they hold has appreciated, selling it could lead to punishing capital gains.

Opportunity Knocks

Concentrated stock positions represent an excellent opportunity for financial advisors, given the assets — and the concerns — of this client group, and most financial services firms will have hedging resources in-house. There are a number of hedging options that can be considered, including puts, collars and variable prepaid forwards.

For those with concentrated stock positions who are charitably inclined (about one-quarter of the executives in our study), there are charitable remainder trusts (see article on page 50).

For financial advisors, there's a major difference between these approaches. When hedged, the stock is not being sold, and it will usually be managed by a hedging specialist, not the financial advisor. The advisor may get a percentage of the hedging fee for having referred the client.

If the client chooses to take a loan against the hedged position, the financial advisor will likely have more assets to manage and can thereby create a more diversified investment portfolio for their client.

With a charitable remainder trust, the stock (or a portion of it) is sold and the proceeds placed in a trust where they could be managed by the advisor, with the money eventually going to a charity or charities.

In either case, the client/advisor relationship should improve because the advisor has been proactive in addressing a key client concern.

For this reason, wealthy executives represent a significant opportunity for advisors to expand their book of business and address a real need among this new and growing segment of investors.

Writer' BIOS:
Russ Alan Prince
is president of Prince & Associates.

Hannah Shaw Grove
is managing director at Merrill Lynch Investment Managers.

Key Financial Concerns of Senior Executives

Investable Assets
$500K-$1M $1M-5M $5M+
Diversifying investment portfolio 9.4% 61.1% 71.8%
The dropping price of company stock 89.0% 84.1% 95.8%
Making a meaningful gift to charity 25.7% 27.0% 22.5%
(N = 388 senior executives. Source: Prince & Associates, 2003.)
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